Does it make any sense to raise the Bank of England's inflation target from
2pc to 4pc? No it does not

There is an amusing, if somewhat academic, debate going on in the blogosphere about whether it makes sense to raise the Bank of England's inflation target from 2pc to 4pc - academic, because even if it did make sense, which it doesn't, it's not going to happen.

I can think of only one worthwhile reason for doing this, which is that it would help Britain, and other countries that adopt such an approach, inflate away their debt overhangs.

The real value of debt is much more quickly eroded with inflation at 4pc than at 2pc. Indeed, that's in part what present ultra-loose monetary policy is meant to achieve. Zero interest rates, in conjunction with "quantitative easing", deliberately favour the debtor over the creditor; it's a sort of backdoor approach to burden sharing, or if you like, a tax on saving.

Rather, it is about creating the space to cut interest rates in response to the next financial crisis. Lifting the inflation rate up to 4pc plainly requires even easier monetary policy than we already have in the short to medium term - Bank Rate at 0pc or negative, and possibly more QE - but once achieved, the equilibrium interest rate needed to stop inflation rising even further would be higher than otherwise.

The argument may or may not have some intellectual appeal, but on a purely practical level, it's a little bit silly. It's not just that if you attempt to generate a higher inflation rate, there is some danger of things getting out of control. Mr Yates is right to argue that these risks are probably quite limited.

Much more importantly, however, the negative interest rates required to generate such a rate of inflation would put another rocket under asset prices, which is about the last thing Britain needs right now from a social and intergenerational point of view. There is nothing more guaranteed to create the financial crisis Mr Yates wants to be able to respond to than an even bigger burst of negative real interest rates.

By the way, I've never understood the Paul Krugman suggestion that those who see runaway inflation under every unturned stone actually have a vested interest in such an outcome because they tend to be super rich creditors who want higher interest rates regardless of the consequences.

Besides being a bizarrely paranoid take on the inflation debate, there's actually no logic in the argument. To the contrary, asset holders benefit from very low interest rates along with debtors, as they raise the value of the assets and mitigate default risk.

In any case, I wonder how much of a difference having a higher inflation target would make in current circumstances. For much of the past seven years, the 2pc target seems to have meant nothing at all, in Britain at least, with inflation frequently above 5pc. There are good reasons for a 2pc inflation target. It's high enough to incentivise evasive action when deflation is threatened, but low enough to keep inflationary expectations well anchored. It makes little sense to create an inflationary problem merely for the sake of dealing with an imagined future financial one.